Post-Brexit: Has it become more important to invest in value stocks?

The Brexit verdict sent tremors through world stockmarkets. The sell-off may have sharpened the appetite for so-called “value stocks”.

08/07/2016

David Brett

Investment Writer

30 MinutesUnstructured Learning Time

The vote to Brexit shocked the world and, arguably, has created opportunities for “value investors”, those who seek to buy shares with strong prospects that are unloved by the market.

For example, in the UK stocks to have fallen furthest include housebuilders, banks and general retailers.

Past performance is not a guide to future performance and may not be repeated.

Sharp stockmarket falls do not necessarily mean shares have become cheap, but our analysis aims to highlight how different segments of the stockmarket have moved and whether they are worth consideration for value investors.

Warren Buffett and the definition of “value investing”

Billionaire Warren Buffet is probably the world’s most renowned value investor. He aims to find shares that are out of fashion. He also applies his own, very simple criteria. He wants businesses to be:

One that he can understand

With favourable long-term prospects

Operated by honest and competent people

Available at a very attractive price.

He also wants to invest in stocks for the very long-term, or “forever stocks” as he describes them.

Where can I find cheap assets?

If it were obvious where to find this value, all investors would grab such stocks.

But there are many factors that influence the performance of value assets, not least the unprecedented economic climate we currently find ourselves in since the financial crisis of 2008-2009, when value stocks have not performed well.

Why has growth outperformed value?

In an uncertain world, investors have been prepared to pay up for what they see as a safer prospect: top quality “growth stocks”.

With these, investors look for certain solid characteristics: companies with low debt that steadily grow profits and already offer a decent return on the money you invest, or high “return on capital”, in the jargon. Investors, essentially, are looking for stocks that mimic government bonds

Also, they often already have a strong and effective management team in place, which is not always the case with value stocks. In effect, investors buy them because they want safe, stable shares.

This has been evident since the credit crisis of 2008.

Value shares are regarded as risky, particularly late in the economic cycle. This is only heightened if investors fear the economy is on the verge of entering a recession, which has been the case for much of the last decade.

Finding value in stockmarkets

In the short-term it is difficult to envisage value stocks gaining the upper hand. Brexit has sprinkled yet more uncertainty into the global economic mix.

So, investing in value will be difficult. Barring a few exceptions, value investors might feel more pain than pleasure in the short-term.

That is not to say that there are not value opportunities. This data offers some food for thought on parts of the market that could be viewed as value. We looked at:

Price to earnings: the profits made in a sector compared with the share price. The lower the number, the cheaper the shares.

Price to book: the price investors are willing to pay for the asset compared with the value of company’s assets. The lower the number, the cheaper the share.

Dividend yield: cash the company pays out as a percentage of the current share price.

Source: Schroders, Bloomberg as at 6 July 2016. MSCI World Value Index. Past performance is not a guide to future performance and may not be repeated. For illustrative purposes only and not to be considered a recommendation to buy or sell.

Using the criteria set out by Warren Buffet, comparatively, financials and utilities potentially offer an attractive proposition for value investors, according to some measures shown in the table. At the other end of the spectrum, consumer and energy stocks are on high valuations.

If it were just a case of buying the cheapest stocks, all investors would be doing it and making large returns, but there are many factors that influence the performance of value stocks.

Why value investing could return to favour after the Brexit turmoil

Before the Brexit vote value stocks had started to perfom well compared with growth stocks.

Source: Bloomberg, April 2016. Chart indicates relative performance of value versus growth. Past performance is not a guide to future performance and may not be repeated.

That could be for a number of reasons but very likely is the fact that growth and “safe haven” stocks had become expensive, compared to the returns they offer.

Brexit has changed the landscape, in the short-term, but the factors driving value stocks prior to Brexit have not changed.

Fear has driven investors into traditional safe havens, but that could leave more opportunities in value stocks should the economic climate change.

When the UK voted for Brexit the market didn’t like it. It fell sharply, but within days the FTSE 100 was back above its pre-Brexit levels. So, what should investors take away from the events of the last week?

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